Draft Economic policies and growth strategies after the ...

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Economic policies and growth strategies after the crisis in USA, Japan and EU. Will the Euro project survive?

Pasquale Tridico Universit? Roma Tre Dipartimento di Economia tridico@uniroma3.it

Abstract The objective of this paper is to investigate how the United States of America (US) and Japan managed relatively better than Europe to emerge from the crisis, which caused a deep recession in 2009, and why instead Europe or more appropriately, the Euro Area (EA) of the European Union (EU), did not. I will examine the main policies implemented by the main fiscal and monetary authorities in the US, i.e., the Federal Reserve (Fed), and the Federal Government; in Japan: the Bank of Japan (BoJ) and the Japanese Government (focusing in particular on the so called "Abenomics"); and in Europe: the European Central Bank (ECB) and EA Member State Governments; and I will try to understand how in the US and Japan these policies caused sustainable recovery in terms of GDP growth and employment, while on the other hand they did not manage to bring about the same results in Europe. The paper will also propose a political agenda for the EA which would favour economic recovery and sustainable development in the next decade, similar to that witnessed by the other two countries (we refer to the Euro Area as a country, at least from an economic point of view, despite the strong weakness of this definition from a political point of view). In this context, the case of Japan (with the so called "Abenomics"), along with the recovery strategy embarked in the US are better examples that Europe should follow. Finally the paper will critically discuss whether the new economic and financial governance implemented between 2012-2016 in EU (from the Fiscal Compact to the Banking Union) is sufficient to overcome the crisis and would be able to continue further the process of EU integration, or could indeed bring about more dangers for further disintegration, in particular after the UK referendum?

Key words: Economic policies, crisis, austerity, economic growth Jel: E5; H63; O4;

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1. Economic crisis and recovery strategies in advanced economies: an overview

The economic crisis which started in the United States' financial sector in 2007 spread quickly around the world, particularly to advanced economies and to Europe. It became a global crisis and involved, between 2009 and 2012, almost all sectors of the economies and caused high levels of unemployment (Posner, 2009; Stiglitz, 2010; OECD, 2010). Mass unemployment emerged in the US and in Europe (Krugman, 2008; Wolff, 2010). After a recession of the GDP in the European Union with an average of -4.2% in 2009, many EU Members States have still not recovered. In 2012, several European countries, particularly in the South and in the East of Europe, experienced a double dip in terms of GDP recession and unemployment, while in other European countries in the core of Europe, GDP is stagnating and the level of unemployment is not declining (Fitoussi and Stiglitz 2009; Barba and Pivetti, 2009; Tridico 2012). Besides that, other problems exist such as low levels of consumption, bank liquidity problems, low levels of private investment, a lack of trust and negative expectations in the financial market and between banks and investors, as well as high public deficits and debts. Despite the variety of problems, the governments of member states and EU institutions (in particular the EU Commission and ECB) focused mostly on a single problem, as I will argue below: the sovereign debt of member states (Fitoussi and Saraceno, 2010).

In order to recover from the crisis, governments in Western economies, particularly the US and the EU, initially in 2007-2009, put in place fiscal stimuli and bank rescue packages. These policies were supported by a great consensus among the policymakers, politicians, and academics who had begun to look at Keynesian policies in a favourable way.

United States In the US under the Bush administration the TARP (Troubled Asset Relief Program) Act was launched in order to purchase "troubled" assets and equity from financial institutions and to strengthen trust in the financial sector (Lowenstein, 2010). The Act allowed the Treasury to purchase illiquid, difficult-to-value assets from banks and other financial institutions as a first reaction to the subprime mortgage crisis, for a value of $700bn US (or 2.3 of US GDP).1 Similar savings plans were implemented in the UK. It is, however, debatable whether the policies introduced in the US and the UK over the period of 2007-2009 represent orthodox Keynesian policies at all. Certainly, as was the case

1More than a Keynesian fiscal stimulus, TARP was an Act made in order to save, in a direct way, financial institutions. Several commentators and newspapers in the US criticized TARP for being a paradoxical representation of a sort of "financial socialism" (Wolff, 2010).

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in the UK, much of this intervention involved direct and indirect handouts to banks with remarkably few strings attached on the assumption that this would enable the latter to rebuild their balances, and encourage them to resume lending to the non-financial sector. In practice, much of this money appears to have leaked out to fund new rounds of speculative activity, whilst the promised `trickle down' has proved limited.

Monetary policies were simultaneously manipulated by Western central banks. A combination of actions by the Fed, the European Central Bank (ECB), the Bank of England and the Bank of Japan, provided a huge amount of liquidity to the private sector, and to the banking sector in particular, in order to avoid the crunch of the inter-lending among banks. The first injections came in the summer of 2007, with the leading role going to the Fed and the Bank of Japan. The ECB and the Bank of England reacted by releasing similar proportions of liquidity into their own financial markets. Moreover, the interest rate in the US had been reduced from 5.25 to 0.25 per cent. In Japan it used to be always at very low levels. Similar action was taken in the UK. In the Eurozone, given that the greatest priority of the ECB was to foster price stability, the interest rate was lowered to 2.5% in 2009 and to 1% in 2010 (Tropeano, 2010; Sawyer, 2010).

Regarding fiscal policy in the US, Obama's fiscal stimulus, (the ARRA - American Recovering and Reinvestment Act) for a value of $775bn US (or 2.7 of US GDP), entered onto the scene in February, 2009, after much debate in Congress (Romer and Bernestein, 2010).2 The stimulus aims to promote, in the Keynesian tradition, job creation, investment, and consumer spending during the recession. To some extent it represents a breakdown of the main economic consensus which favored spontaneous recovery, i.e., recovery driven by the market or, in the less conservative case, monetary policy (quantitative easing) over fiscal stimulus. However, economic recover, in terms of GDP, was immediately guaranteed, with growth of around 2% since 2010.

2 No Republicans in the House voted for the bill, while in the Senate only three Republicans voted for it

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draft Figure 1 ? US: economic crisis and recovery

Source: own elaboration on Eurostat and IMF data

Japan In Japan the situation before the global economic crisis was very different than in USA or in EU. Japan's economy during the 1990s experienced a serious stagnation of GDP, which started after the burst of the housing bubble at the end of 1980s and the beginning of the 1990s. Deflation and lower growth characterized Japan for almost two decades, and the consequences on the explosion of public debt were enormous: today Japanese public debt is a bit less than 250% of GDP. In 2008 and in 2009, during the global economic crisis, Japan's cumulative recession was about -6% of GDP. However, since the end of the global crisis, and particularly after the 2011 recession caused mainly by the terrible Tsunami and earthquake which destroyed the nuclear power plant in Fukushima, the Japanese economy seems to have embarked on a path of economic recovery clearly linked, according to many economists, to the so called "Abenomics" (Irwin, 2013; The Economist, 2013a; IMF, 2013). Abenomics refers to the economic policies implemented by Shinz Abe, the Japanese Prime minister since 2012. Abe was Prime Minister already in 2006-2007 and also during these two years. His attempt to boost the Japanese economy with monetary expansion and fiscal stimuli, although less strategically organized since 2012, was able to produce economic growth of about 2% a year. Abenomics is based on three pillars: fiscal stimulus, monetary quantitative easing and structural reforms. In other words, Abenomics is a program characterized by a "mix of reflation, government spending and a growth strategy," as The Economist (2013b) argued, aiming to raise the economy from two decades of

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draft suspended stagnation. Abenomics consists of monetary policy, fiscal policy, and economic growth strategies to encourage both public and private investment. Since 2012 Japanese policymakers have implemented a strategy which includes inflation targeting a 2% annual rate, the correction of excessive yen appreciation, the setting of negative interest rates, huge quantitative easing, expansion of public investments, buying operations of treasury bonds by the Bank of Japan (BOJ), and the revision of the Bank of Japan Act which impeded higher inflation targets. During 2013 the Yen devalued 25% over the US dollar, boosting exports and increasing the trade balance. However, after the 2011 nuclear disaster in Fukushima and the subsequent political decision to shut off all nuclear power in Japan, energy started to be heavily imported. This may have negative results in the long run with the Yen continuously devalued. Nevertheless, the results of this program are positive so far: the economy started to grow; and deflation seems defeated, with a new target of 2% which both the Bank of Japan (BoJ) and the Government seem to pursue simultaneously and coordinately3. Unemployment decreased further, reaching below 4% in 2014. (Haidar and Hoshi; 2014; Wolf, 2013; Irwin, 2013).

Figure 2 ? Japan: economic crisis and recovery

Source: own elaboration on Eurostat and IMF data

The Euro Area

3 The new behavior of coordination and cooperation between BoJ and Government was heavily criticized by some orthodox analysts and economist, as this is a violation of the independence of the Central Bank (Weidmann, 2013)

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In the EU the fiscal stimuli, implemented singularly by MS, mobilized around $300bn US of resources (or 1.5% of EU GDP) (IMF, 2009). However, fiscal policies among member states are fragmented and often uncoordinated. Moreover, the EU is a supranational organization with much less power than the US federation and little possibility of economies of scale. Seventeen countries adopted the Euro and, consequently, the ECB and the Maastricht criteria which impose common monetary policies, fiscal constraints and harmonisation. Nine other countries maintain their own currency and sovereignty over their monetary policy, financial systems and fiscal policies.4 This means that Europe has ten different currencies.5 This represents a concrete difficulty in policy coordination. However, the biggest problem in this context, relates to the fact that the UK is not part of the Eurozone. The UK is the second largest economy in the EU and the British Pound is still an internationally important currency, with London as the biggest financial centre in Europe (Wahl, 2010). Market capitalization in London is 1,962 trillion (2010 data), while Frankfurt and Paris have around 0.900 trillion each in market capitalization (Eurostat 2010). When national interests are on the table, EU members states, and in particular the UK, demonstrate a strong opposition to EU financial regulation and supranational power (UK Treasury Committee, 2010).

The total EU fiscal stimulus in 2009 was around 1.5% of the total EU GDP, but not all countries acted on the suggestions of the EU Commission. Spain, which was one of the countries hit hardest by the crisis, put in place the biggest stimulus in Europe, favoured by a socialist government, of 3.7% of GDP. This plan focused on 40 billion to support infrastructure investments and the automobile industry. France's plan was smaller, 26 billion, which includes a boost for the construction and automobile sectors; moreover, the government has promised 20 billion for small businesses and the construction industry. Germany's package includes generous amortization rules for companies and incentives for climate-friendly home renovation; the total package is expected to reach 82 billion, including private investments. Italy proposes a nominal stimulus for unemployment subsidies and firm support that will only amount to 9 billion. The UK has announced a temporary reduction of the VAT rate from 17.5% to 15%. In addition, the government plans to invest 31 billion on infrastructure.

The outcomes of these stimuli were quite positive: in the second quarter of 2010, Germany grew at an extraordinary rate of 8.8%, and the UK at 4.8%. Similar stories, although of less magnitude, occurred in other European economies. Figure 3 ? The Euro Area: economic crisis and recovery

4 Bulgaria, Czech Rep., Denmark, Hungary, Lithuania, Poland, Romania, Sweden and UK are outside the Euro Area. 5 The currencies of Bulgaria, Denmark, Latvia and Lithuania are pegged to the Euro.

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Source: own elaboration on Eurostat and IMF data

Nevertheless, in the US and Japan, expansionary policies, quantitative easing, a continuous and program of buying Treasury bonds, and lower interest rates continued to the present. In the EU, already after the spring of 2010, the policy consensus switched towards austerity measures. After the Greek crisis, governments turned their interests, irrationally, toward budget cuts and policies of contraction (Arestis and Pelagidis, 2010). In the fall of 2010, the new Liberal-Conservative government in the UK implemented an austerity plan with cuts in public expenditures and a freezing of public employment wages and jobs for the next three years. Chancellor Merkel proposed similar restrictive plans in Germany, and other continental European countries are preparing financial laws very much focused on restrictive fiscal measurements. The objective is to reduce deficits. This seems more like a reaction to the Greek and Irish crises, rather than a rational decision which would help economic recovery (Arestis and Pelagidis, 2010).

At the same time, the actions of the member states, particularly in the South of Europe, were, and still are, strongly limited by the tough rules of EU treaties such as the Maastricht Treaty and the Stability and Growth Pact which were reinforced, as we will argue later, in the last 3 years. They became tighter in terms of austerity and public expenditure rules with the introduction of the so called "Fiscal Compact", the "Six-pack", and the "Two-pack", which impede member states from implementing deficit policies if they have macroeconomic imbalances. This is a vicious circle which does not allow MS policy makers room for maneuvers unless the treaties are violated or changed.

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2. Quantitative easing in US, Abenomics in Japan and Austerity in Europe

Two major challenges emerged during the crisis: the rise of unemployment with growing public deficits and financial instability threatening economic development. In this context, Europe, and the Euro Area in particular, seems stuck in a stagnation trap, without private investments, and with policy makers refusing to increase public deficits and public investments which would help the economic recovery. In fact, while the other major advanced economies managed, through expansionary policies to end the crisis, the Euro Area is very much worried about price stability. In 2014 the situation is very clear: Japan and the USA are emerging from the crisis. They reduced unemployment and started economic recovery through expansionary policies which are visible in both the increasing of the public spending, resulting in higher deficits, and the loosening of monetary policies, resulting in lower interest rates. Finally, deflation was defeated in Japan after 20 years and new targets of inflation rates deliberately met by the BoJ were reached above 2%; similarly, in the USA there are no worries about inflation nor deflation. On the contrary, in the EA, the spectrum of inflation mostly spread by Germany, and the consequent more prudent monetary and fiscal policies operated by the ECB, lead instead toward the specular and major problem of deflation. In 2014 the risk of a deflation spiral is real, with the average price index close to zero, and in some countries, like Italy, below zero.

Figure 4 - Japan, USA and EA public debt, unemployment and deficit in 2014

EA Japan

Inflation 2014 1 1.5 2 2.5 3

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U nem ploym ent 2014

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USA

Japan

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-6

-5

-4

-3

Deficit 2014

USA EA

-7

-6

-5

-4

-3

Deficit 2014

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